How Tax Works for Someone Who Leaves Their Job?

Being employed has its perks. You don’t have to worry too much about taxes. Your employer deducts tax from your salary and pays it to the Canada Revenue Agency (CRA) on your behalf. However, you should assess your tax liability if you are leaving your job or have received a termination letter. 

What Happens When You Leave Your Job?

When you leave your job voluntarily or via termination, your employer pays you money that could fall under income tax purview. However, the tax treatment will depend on how you get the income as its definition changes in the Income Tax Act. 

Regular Employment Income: Suppose your employer gives you a 12-month notice of termination. In these 12 months, you get your salary and benefits the same way as you were while employed. Such an arrangement is treated as regular employment income, and the tax treatment is the same as salary. Your employer deducts the Canada Pension Plan (CPP), income tax, and employment insurance from your salary. 

Retiring Allowance: Another scenario is that your employer offers 12 months’ severance or an “early retirement” package, and you accept the offer. Here, you are getting a lump sum amount called a “retiring allowance” in the Income Tax Act. It is taxable. 

The Tax Treatment of Retiring Allowance 

As per the Income Tax Act, a retiring allowance is not an employment income, which means: 

• It creates no RRSP contribution room (18% of your annual income). 
• You do not have to pay CPP or EI premium on this income. 

Your employer will withhold tax on the retiring allowance in the following order: 

• 10% for amounts up to $5,000,
• 20% for ($5000.01 to $15,000), and 
• 30% for $15,000.01 and above. 

You will receive the retirement allowance after deducting the withholding tax. If you get $50,000 after withholding tax, you must still add this amount to your taxable income. You can also deduct the withholding tax already paid by your employer from your tax liability. If you fall under the 50% tax bracket, you must pay an extra 20% tax on the retirement allowance from your pocket. 

The Tax Treatment of Retiring Allowance for non-resident

If you become a non-resident for tax purposes, a flat rate of 25% non-resident withholding tax will apply to you on your entire taxable retirement allowance. No bifurcation of 5%, 10%, or 15% apply. If you fall under the higher tax bracket of 50%, you would benefit from becoming a non-resident before receiving the retirement allowance. 

There are other ways you can save tax on retirement allowance. 

How To Save Tax on Retiring Allowance 

RRSP Transfer: If you have been working with this employer before January 1, 1996, you can transfer $2,000 to your Registered Retirement Savings Account (RRSP) for every year you worked for the employer before 1996. For instance, you have been working with John since 1990. You could transfer $12,000 ($2,000 x 6) to your RRSP from 1990 to 1995. 

You can deduct the $12,000 from the retiring allowance transferred to the RRSP from the taxable income. 

Note: If your employer transfers the above amount to RRSP, withholding tax won’t be deducted. However, if you are transferring to the RRSP, withholding tax would be deducted. You have to transfer the amount to the RRSP within 60 days after the end of the tax year (the RRSP deadline) to avail yourself of the tax benefit. 

Pension Plan: Suppose you were not a member of a pension plan or deferred profit-sharing plan, but you have the right to those plans. In such a scenario, you can reduce an additional $1,500 from your retiring allowance for each year you were employed before 1989. This amount transferred toward the pension plan is not taxable. 

The above two deductions could help you reduce your taxable retirement allowance. 

The Tax Treatment on Settlement Payments from Lawsuits 

Another way you can get a payment from your employer is if you do not accept your employer’s offer, file a lawsuit for wrongful dismissal, claim damages and get the claim. Such damage claims can be non-taxable but will likely be scrutinized by the CRA for not reporting such income. Make sure you file a lawsuit, keeping income tax in mind. The document should explicitly show the amount as “punitive damages” or “exemplary damages” as they are non-taxable. Moreover, you can deduct the legal expenses from your taxable income.  

The severance pay from job loss is crucial. You don’t want the CRA taking a significant tax bite from it. 

Contact Hagar Liao CPA Professional Corporation in Oakville to Help You with Tax Planning 

Talk to a professional tax consultant to help you assess your scenario and identify the various exceptions and exemptions that could be applied. To learn more about how Hagar Liao CPA Professional Corporation can provide you with the best tax consultation, contact us online or by telephone at 289-803-1818.